A recent FCA survey investigated how well investors understand and value structured deposits, questioning almost 400 previous structured product and deposit users. The results concluded they over-estimated the products’ returns potential.
However, both the methodology and the findings of the survey warrant analysis in finer detail, which throws up some questions and concerns, and, in my opinion, inhibits its wider applicability.
In the FCA study, investors were shown hypothetical examples of five types of products, all based on the FTSE 100. The research use quantitative modelling in order to replicate market value, and the structured products were then compared to fixed-rate deposits.
Firstly, the five-year deposit rate used for comparative purposes in the survey was based on the best rate available, at 3 per cent per annum. While StructuredProductReview.com cannot comment on the products that were being sold by banks and building societies, the products that were hypothetically constructed for the purposes of the survey bore little resemblance to those actually on offer in the IFA space in early 2013 (the time from which the paper states the products were selected).
So, comparing the best of cash with some very poor value structured deposits and extrapolating observations about customer behaviour is not as meaningful as a study designed to be academically objective is intended to be.
For example, the ‘basic’ structured deposit designed for the survey offered 50 per cent of the growth in the FTSE, whereas in early 2013 you could invest in a deposit that offered 100 per cent of the growth (subject to final six month averaging).
Therefore, the participation rate of the ‘capped’ product in the survey, 100 per cent, matched that of a real product that had no cap, available in the IFA space at that time, which is a significant difference.
The most complex product type, the ‘cliquet’, used in the survey was not on offer at all in the IFA space at that time, and to the best of our knowledge at StructuredProductReview.com hasn’t been for some time.
In addition, the assumed fees used in the survey products were 7.5 per cent – which bears little resemblance to products seen within the IFA market post RDR and is misleading.
There are also other aspects of the technical analysis that concern us, which might account for some of the apparent overestimation of anticipated returns by the survey respondents.
The kick-out product example used is described as offering a 4.5 per cent coupon for each year held. The paper and therefore, presumably, the survey analysis, suggests that this product would be expected to mature after two years. If this occurred, clearly the product would produce a gross return of 9 per cent, 4.5 per cent for each year. But the paper states that the expected payback would be a gross return of 4.9 per cent. Whether this apparent error had any impact on the survey findings is not clear, but it is not inconceivable that, in the worst-case scenario, this could account for an element of the headline findings.
The kick-out structured deposit in the survey, compared against the other product types, showed the smallest gap between investor expectations of the performance of the product and FTSE expectations. This highlights how investors may find it easier to think about products in terms of annual coupons that can be achieved in the simple event that the FTSE is higher, rather than a percentage level of participation in the rise in the index, or the complexities of a ‘Cliquet’ product.
However, in the IFA space, in recent years and today, there have certainly been products offering attractive returns for the risk taken. The results of 80 IFA-distributed structured deposits that matured in the 12 months to the end of February 2015 show this.
The average performance was 5.47 per cent per annum, over an average term of just over four years. The top quartile performance was an average annualised return of 7.74 per cent, while the bottom quartile average was 3.28 per cent. These are surely amongst the best returns achieved by cash-based investments over recent years, in the real world, as opposed to poor high street or hypothetical products with hypothetical returns.
Whilst the FCA thematic review has led to some negative headlines and we have some questions as to the methodology used, the general findings are not unreasonable and anything that leads to better practices, better products and improved consumer outcomes is of course very welcome.
The regulator says itself that structured deposits have a place in the market. We certainly agree and while no single solution is ever going to be the holy grail of investment, well designed, fairly created and appropriately advised upon structured products, with their selling point of known outcomes in known circumstances, are worthy of consideration for an investor’s portfolio – and we are keen to see the market continue to evolve for the better.
Ian Lowes is founder of website StructuredProductReview.com.
The methodology used by the FCA in its structured products research did not represent the market. However, anything that can help to improve products, policies and customer experiences should help the industry.